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How foreign currency translation is applied under IAS 21 and ASC 830

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Foreign currency translation ensures that transactions and subsidiaries operating in different currencies are correctly reflected in the reporting entity’s functional currency. IAS 21 (The Effects of Changes in Foreign Exchange Rates) and US GAAP (ASC 830 – Foreign Currency Matters) both govern how to translate transactions, monetary balances, and foreign operations into the presentation currency, but they differ in terminology, measurement hierarchy, and treatment of translation adjustments.

Both frameworks aim to capture exchange rate effects transparently, distinguishing between transaction gains or losses in profit or loss and translation differences recognized in equity.

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How the functional and presentation currencies are determined.

Functional currency is the primary currency of the entity’s economic environment—the one in which it generates and expends cash.Presentation currency is the currency in which financial statements are presented.

Factors in determining functional currency:

  • Currency influencing sales prices and costs of goods.

  • Currency of financing and operating cash flows.

  • Autonomy of foreign operations.

Under IAS 21, once determined, the functional currency is not changed unless significant changes occur in underlying transactions.Under ASC 830, functional currency follows similar principles but explicitly recognizes highly inflationary economies (treated as if the functional currency were that of the reporting entity).

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How foreign currency transactions are initially recorded.

Transactions denominated in foreign currencies are translated into the functional currency using the spot exchange rate on the transaction date.

Example:A company purchases goods from a US supplier for USD 50,000 when 1 USD = 0.90 EUR.→ 45,000 EUR recorded initially.

Entry:

  • Debit: Inventory 45,000

  • Credit: Accounts Payable 45,000

If the balance remains unpaid at reporting date and the exchange rate moves to 1 USD = 0.95 EUR, the liability increases to 47,500 EUR, resulting in a loss of 2,500 EUR.

Entry:

  • Debit: FX Loss 2,500

  • Credit: Accounts Payable 2,500

IAS 21: recognize gain or loss in profit or loss.ASC 830: same rule — FX gains and losses recognized in income.

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Translation of foreign operations under IFRS (IAS 21).

When a foreign subsidiary has a different functional currency, its financial statements are translated into the parent’s presentation currency for consolidation.

Steps under IAS 21:

  1. Assets and liabilities: translate at closing rate on the reporting date.

  2. Income and expenses: translate at average rate (approximation of actual).

  3. Equity items: translate at historical rates.

  4. Translation differences: recognized in Other Comprehensive Income (OCI) within Foreign Currency Translation Reserve (FCTR).

Example:Subsidiary’s balance sheet (USD):Assets 1,000,000 | Liabilities 600,000 | Equity 400,000Closing rate: 1 USD = 0.90 EUR

Translated values:Assets 900,000 | Liabilities 540,000 | Equity (historical) 360,000 → difference of 0 (balanced).

Translation difference recorded in FCTR to balance conversion adjustments from income and net assets.

On disposal: cumulative translation difference reclassified to profit or loss.

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Translation of foreign operations under US GAAP (ASC 830).

1) Functional currency approach.Similar to IFRS: use functional currency concept to determine whether to remeasure or translate.

2) Translation (functional currency ≠ reporting currency).

  • Assets and liabilities: closing rate.

  • Income and expenses: average rate.

  • Equity: historical rates.

  • Translation adjustments: recorded in Accumulated Other Comprehensive Income (AOCI) until disposal.

3) Remeasurement (functional currency = reporting currency).If a subsidiary operates in the same currency as the parent or in a highly inflationary economy, remeasure local accounts as if functional currency were the reporting currency:

  • Monetary items → closing rate.

  • Non-monetary items → historical rate.

  • Resulting gains/losses → P&L.

4) Highly inflationary economies.When cumulative inflation exceeds ~100% over three years, treat local currency as nonfunctional and use parent’s currency for remeasurement—aligning with IAS 29.

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Comparative table: IAS 21 vs ASC 830.

Aspect

IFRS (IAS 21)

US GAAP (ASC 830)

Functional currency

Currency of primary economic environment

Same concept

Translation model

Assets/liabilities closing rate, income/expense average

Same

Translation adjustments

OCI (FCTR), reclassified on disposal

AOCI, reclassified on disposal

Remeasurement

For foreign transactions in non-functional currency

For entities using parent’s or inflationary currency

Highly inflationary economy

Apply IAS 29 + IAS 21

Use USD as functional currency

Exchange differences on monetary items

Recognized in P&L

Recognized in P&L

Goodwill and fair value adjustments

Treated as assets of foreign operation

Same

Disclosure requirements

FCTR movement, rates used, subsidiaries affected

Same, plus SEC filers include rate sensitivity

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Example — consolidated translation adjustment.

Parent (EUR functional) owns 100% of Subsidiary (USD functional).Subsidiary equity at beginning: USD 500,000.End of year: USD 520,000.Exchange rate change: 1 USD from 0.90 → 0.95 EUR.

Translation difference:Opening equity (500,000 × 0.90) = 450,000 EURClosing equity (520,000 × 0.95) = 494,000 EUR→ Gain 44,000 EUR → Recognized in FCTR (OCI).

Entry:

  • Debit: Investment in Subsidiary 44,000

  • Credit: Foreign Currency Translation Reserve 44,000

Upon disposal of the subsidiary:

  • Debit: FCTR 44,000

  • Credit: Gain on Disposal 44,000

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Disclosures required.

IFRS 7 and IAS 21 disclosures:

  • Exchange rates used for translation.

  • Nature of functional and presentation currencies.

  • Amount of FX gains/losses in P&L.

  • Movement in FCTR and reclassifications.

ASC 830 disclosures:

  • Breakdown of translation adjustments in AOCI.

  • Policy on determining functional currency.

  • Total FX gains/losses in income.

  • Identification of operations in hyperinflationary economies.

Example disclosure:

Item

Amount (USD)

Foreign currency transaction losses (P&L)

75,000

Translation gain in OCI (FCTR)

110,000

Reclassified from OCI to P&L on disposal

(45,000)

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Journal entries summary.

1) Foreign currency purchase:

  • Debit: Inventory xx

  • Credit: Accounts Payable xx

2) Exchange rate change:

  • Debit: FX Loss xx

  • Credit: Accounts Payable xx

3) Translation reserve (subsidiary):

  • Debit: Investment in Subsidiary xx

  • Credit: FCTR (OCI) xx

4) Disposal reclassification:

  • Debit: FCTR xx

  • Credit: Gain/Loss on Disposal xx

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Impact on financial performance and ratios.

Foreign currency effects influence:

  • Profit volatility through transaction gains/losses.

  • Equity through FCTR or AOCI movements.

  • Return on equity (ROE) and book value per share via accumulated translation reserves.

  • Cash flow comparability when multiple currencies are used.

Exchange rate sensitivity analyses are critical for investors assessing global exposure and volatility in reported results.

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Operational considerations.

Companies with multinational operations should:

  • Regularly confirm each entity’s functional currency.

  • Automate translation rates in ERP systems.

  • Use consistent average and closing rates for consolidation.

  • Monitor hedging relationships (IAS 39/IFRS 9 or ASC 815) to offset FX volatility.

  • Reconcile OCI movements for accuracy across reporting periods.

Accurate foreign currency translation ensures that consolidated financial statements present an integrated and realistic view of international operations under both IFRS and US GAAP.

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